Before we get into tips for using credit cards more effectively, first, let us understand why are banks giving various types of credit cards for free or at a very nominal cost. What’s in for them? How are they making money?
How banks make money?
We all keep getting a lot of unsolicited calls on credit cards. Let us understand why banks sell credit cards for free. A credit card is an unsecured loan, which means banks do not hold any security from us as a mortgage, unlike a home loan as an example. So, it is a risky loan in their books and to compensate for that risk, they charge high-interest rate from customers. But then they also provide an interest-free credit?
This interest-free credit is only applicable for predefined number of days. After that, if the bank does not receive payment in full, they start charging interest rate for the outstanding amount. This interest rate is very high (remember the loan is unsecured!) as high as 40% per annum. This would be the case even if you have just Re 1 outstanding on your credit card bill! Your interest-free period is now ZERO and you get charged for any purchase you make from thereon until you clear the entire outstanding amount.
The business model for banks
So, the banks are providing you a credit card for free. Taking fees for this credit card is not their model. It is only a bait for them to attract more customers, lure them into high credit limits, get them to buy more, and then not make the payment in full. That’s when they can get all these charges by way of late payment, interest rate, default charges, etc.
So, the few “bad people”, or what I would say “unplanned people” actually more than compensate for the good and planned people who are paying their bills on time, every time, availing the interest- free credit and also all the associated rewards points and cash backs. More the cards are used by “unplanned people”, more money the banks make. Banks also make money when they provide the swipe machine to a merchant for swiping credit cards in which case the merchant ends up paying 1 to 2% transaction fees to the banks. This would also explain why some merchants charge money on swiping a card since they need to make this payment to the banks through the intermediaries.
What can we learn from this?
Using a credit card needs the discipline to keep our purchases under check. Just because we don’t have to pay now does not mean it is free. Also, the discipline to make the payment on time, a few days before if making payment by cheque. Or better still, time your billing cycle in such a way that your bill payment date is soon after your salary gets credited. Then provide an auto-debit instruction to your bank for this payment in full. That way, you do not miss any payment. Also, if there are any disputes in the bill, better approach is to first make the payment and simultaneously raise the dispute with the bank. Normally, the bank first reverses the amount, then does an investigation on that dispute.
Tips for using credit card effectively
1. Have two credit cards with different billing cycle
It is always a good idea to make a big-ticket purchase soon after your billing cycle has started so that you can get maximum interest free credit. Sometimes, it may not be possible to time it perfectly. So, you could have another credit card which could have a billing cycle two weeks apart. That way, you could plan purchases well. I would also prefer that one credit card is Visa while the other one is Master card. Sometimes, there are offers in different categories and so that could also be a parameter to make a decision on which credit card to use.
2. Reward points
Some high-end credit cards also have very attractive reward points on them. Most of these cards would have an annual fee or a minimum commitment of a purchase value every year. Evaluate how much are you spending and then make a decision whether you would like to opt for such cards. There are also lot of co-branded cards available and you may decide based on your need of those services
3. Cash backs
Generally, cash backs could be preferred, as you are getting the money upfront versus reward points which is a rebate applicable on time-bound future purchases, and may have along with it its terms and conditions. But, if rewards points are more attractive, then go ahead with that. All schemes of these types are funded by the interchange fees which are the transaction fees charged by the bank from the merchant, as discussed earlier. Providing these schemes and offers is one of the marketing tactics by the banks to lure you to spend more and then hopefully get into a debt trap when they start making more money from you.
4. Pay outstanding balance in full
Be the financially savvy person and not fall into the trap laid out for you. Never keep money in low-interest investments like a saving bank, or a fixed deposit, or even equity investment, for that matter and pay credit card dues at 40% p.a!
5. Avoid credit cards with an annual fee
A credit card is not a status symbol. That may have been true many years back when they were launched. Know what works for you best and make the decision accordingly.
6. Do not have too many credit cards
While you may be thinking that there could be better offers on different cards and that can benefit you well, it will become a challenge to manage so many of them and there is a higher chance of defaults, which can hurt more not only by way of penalties but also a dent in credit score and your credit report. CIBIL may also perceive you as “credit thirsty”.
7. Keep a track of your statements
When you get a statement on e mail, please do have a quick look to check if there are any entries that you do not understand. Get that sorted out soon.
8. A credit card is not ATM:
It is extremely expensive to withdraw cash on your credit card from an ATM as it is considered as an unsecured loan. For your regular cash needs, you should use the ATM debit card.
9. Avail SMS facility
Even if it is a cost, it is still needed. You will be alerted in case of any unauthorised transaction on your card (due to phishing etc). You can then call up the bank and then let them know about it.
10. Be wary if there is a fraud on credit card
It may not still be safe if you have the credit card with you. You may be aware of cloning and phishing which happens. If you think only you know the PIN, even then it may not be safe. We do not need a PIN for payments less than Rs 2000. The EMV cards which are issued now are more secure as compared to magnetic strips in the past.
11. Do not share the CVV with anyone. Memorise and scratch it
If only you know your CVV number, even then you are not secure. International websites do not need a CVV number. It is a good practice to scratch your CVV number on the back of your card. Even if someone finds your credit card, it does not get misused at least in online transactions on an Indian website. Though at a physical merchant, it can still be, if the signature gets forged. But perhaps, with cameras being there in a lot of shops, a person wanting to do the fraud may consider it risky.
12. Swiping of the card in front of you
Insist that swiping happens in front of you, whether in a restaurant or elsewhere. Else, the possibility of card getting cloned.
13. Sign on the back of your credit card as soon as it is received
Merchants are mandated to check and compare signatures (if it is not PIN-based transaction). Else, it is their fault if it comes in an investigation that signatures are different. Besides, if someone steals your card, he cannot sign there since you have put your signature already.
14. While doing online transaction use only secure websites
This secure protocol is https://, which could protect you from phishing as compared to http:// which is less secure.
15. Be wary of the machine used for swiping the card
If it looks suspicious, then beware. It could be a skimmer machine that could steal your data.
16. Use a credit card with a small limit for online shopping
If you want to have a third card only for online shopping, that’s fine, but consider a low limit for that card. Else, better still, there are also virtual credit cards available for online shopping.
17. If not doing International transactions, then disable it
You can always enable it when you are travelling, or even set a lower limit if you plan to use the card for shopping or making payments at International sites. Remember they could be riskier and also, they do not even need the CVV!
Credit card is a great way of managing your personal finances, getting an interest free credit along with reward points and cash backs. But if not used responsibly, it is a stepping stone to get closer to a debt trap. If you are one of those who are not able to control your spending spree while shopping, or are not planned and tend to forget due dates often, then it could be time for you to cut the credit card and start using a debit card.
If you have any interesting tips or a story to share, then please comment below. To read more such blogs on personal finance topics, please visit my website.